In 2007, we spoke to a number of Business Owners about selling their businesses.  We spoke to them about the potential for a recession looming around the corner, principally because of what we saw as the “bubble” in both Commercial and Residential Real Estate.  Many of them declined to sell at that point, stating that there businesses were simply doing “too well”, at that point.

As we moved into the deepest part of recessionary regression in 2008, many of those same people came back to us and then wanted us to sell their businesses, and sell them as quickly as humanly possible.  Unfortunately, as we looked at their Financial Statements, the erosion of their Revenue and Profits suggested that the value of their respective businesses had dropped tremendously.  They could no longer command the kind of Prices they might’ve enjoyed in 2007, and in some cases their businesses were unsalable, at almost any reasonable Price.

The moral of this is certainly not that we are blessed with some sort of crystal ball, and that what we say is tantamount to gospel!  But there are certain rules of thumb regarding the timing of selling businesses that cannot be argued.

First and foremost is the fact that if you own a business, you always – emphasis on the word, “always” – want to sell when you are doing “well”.  No one wants to buy your business when it is in a downward spiral.  And even when the Revenue drops slightly, it creates alarm bells for a Buyer and his/her Lender.

Buyers and Lenders ask for Financial Statements for the past three (3) years, to determine historical trends on which a buying or lending decision is ultimately made.  They want to see that the business has a stable financial record at the very least, and preferably shows growth throughout that trending period.  Any decline of any kind raises concern.  Is that decline a temporary one, or does it represent a larger, more long-term deterioration in business that will continue with the new ownership?  The current owner may explain the reason for the drop in business and the fact that the decline is essentially behind him/her, but Buyers and Lenders cannot and will not take such an explanation as gospel.

They need proof, and that proof can only be borne out by a return to normalcy, as exemplified by Financial Statements.  They are certainly not going to take the word of someone who’s business is in decline, and whose method of dealing with the difficulty is to get out.

This means that the Seller simply has to wait it out, rebuild profitability and then show financial statements that demonstrate the return of the business.  Depending upon how much business has been lost in the decline, this could mean waiting a full Fiscal Year of resurgent business, or more.  There are some mechanisms we have used to provide evidence that a business has been rebuilt in a credible way to a Buyer in less than a year, but Lenders are far more difficult an audience.  They will frequently require at least a year of evidence that the business has been rebuilt to a satisfactory level, and that evidence is just as frequently only supported by a Tax Return, to that effect.

A second element of timing has to do with interest rates.  When a Buyer makes a decision to buy a particular business at a particular Price, the amount of Cash Flow is one of the most critical issues.  Cash Flow, in this case is loosely defined as the amount of money the Buyer can project at the end of each year, after all expenses have been paid except what he/she needs to pay Debt Service, followed by whatever is left to provide him/her with a Personal Income.  Debt Service is further defined as what the Buyer will need to pay the Lender, on a monthly or annual basis, in order to purchase the business.

The Cash Flow is normally projected on the basis of historical profitability of the business, which obviously then goes back to the Financial Statements discussed above.  The relative certainty over the ability to project Cash Flow is obviously then why the confidence in the stability of Revenue and Profits is such a vital concern.

The projection of the Buyer’s Personal Income is something that can also be projected, with relative ease.  He/she knows what he/she pays in rent or house payments, car payments, utilities, average credit card payments, and so forth.  If the business is purchased through an SBA loan, the bank will demand this information, in writing.  The total of this amount is somewhat set in stone.

The amount paid for Debt Service is also somewhat set in stone.  With the amount of average Cash Flow, minus the amount of Personal Income the Buyer requires, that net amount that results is the money left for Debt Service.  From a Lender’s perspective, this is the dollar amount that is viewed with a certain amount of reverence.  The Lender will require that this amount equates to the monthly or annual Debt Service, normally plus about 25% to provide the Buyer with a certain amount of working cash reserves.

And Debt Service itself can be broken down into the sum of payments made toward Interest plus Principle.  This is where understanding the impact of Interest Rates is of critical importance to a business Seller.

Because we know that Debt Service is, as stated above, somewhat set in stone as a total amount, if Interest Rates rise, payments toward the Principal must come down, in order to meet that total.  Business loans are almost always amortized on a 10-year term, so reducing the payments for the Principal by increasing the amortization is not an option.  The only variable that remains is the Price paid for the business.

This means that, if Interest Rates rise, the Price paid for the business must come down.

This is where the politics of the US Government will radically impact any business that is for sale.  Regardless of whether a Seller is a Democrat or Republican, understanding the dynamics of changes in the makeup of the Senate, the House of Representatives or the Presidency, and the impact of such changes on the economy and the Federal Reserve system, is critical in understanding when it might be time to sell a business.

Finally, any recession is liable to wreak havoc on a business sale.  During recession of the 1980s, the Federal Government sought to ease the impact of the recession by devoting more resources in the way of SBA support to small businesses.  Virtually any economist around will say that small businesses led the recovery of the economy, during that time.  In 2008, the way the federal government dealt with the economy was largely to ignore small businesses, in favor of salvaging larger enterprises, such as AIG and GM.  Whether this was right or wrong will not be argued, in this essay.  But the net effect was the fact that small businesses suffered dramatically, and for a period of six months or more, the SBA was virtually out of business.  The only way to sell a business at that point in time, was for the Seller to take a note.

As this is being written in mid-2015, the effects of some of the policies and practices of that time are still being felt.  In many cases, Buyers cannot obtain an SBA loan from some of the largest, national banks; they are faced with going to local or regional banks to obtain those kinds of financing.

This post in our blog is being written well in advance of a changeover from the Obama Administration, but it is not too early for a Business Owner to contemplate selling his/her business before a new administration is put into place.  Selling a business takes time; it is not like flipping a switch.  The Business Owner that is been on the fence about doing so, should seriously think about doing that now.  The Fed has already hinted that interest rates will probably rise in the fall of 2015, which will then probably have a dampening effect on prices that can be demanded for any given business, regardless of how well they might be doing, at this time.

Moreover, for the reader that may be viewing this post well after the 2016 elections should take all of this to heart, because this philosophy will not only impact a changeover from President Obama to whomever succeeds him; it will impact any interim or general election that might take place in the future, as long as Interest Rates themselves are not cast in stone.

(The BAF Group LLC is a full service Business Brokerage, with a history of more than a decade of service. Its Principal Broker possesses 25+ years of Business Sales and Divestiture. Although most of our work is involved in the Mid-Atlantic States, we have represented Sellers and Buyers throughout the Continental USA, and a number of overseas Buyers, as well. Some of our listings and additional information about us can be viewed at www.bafgroup.com. Or, you may contact us at combroker@bafgroup.com. Thank you for your interest.)

Advertisements